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Why Do Individuals Choose Defined Contribution Plans? Evidence from Participants in a Large Public Plan

In: Retirement Benefits for State and Local Employees: Designing Pension Plans for the Twenty-First Century

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  • Jeffrey R. Brown
  • Scott J. Weisbenner

Abstract

We examine individual choices between a defined contribution (DC) and a defined benefit (DB) retirement plan at a large public employer. We find sensible patterns with regard to standard economic and demographic factors: the probability of choosing the DC plan decreases with the relative financial generosity of the DB plans versus the DC plan and rises with education and income. Using a survey of participants, we find that the ability to control for beliefs, preferences, and other variables not easily obtainable from administrative or standard household surveys increases the explanatory power over seven-fold. Among the important factors in the DB/DC pension choice are respondent attitudes about risk/return tradeoffs, financial literacy, return expectations, and political risk. We also find that individuals make sensible choices based on what they believe to be true about the plans, but that these beliefs about plan parameters are often wrong, thus leading to possibly sub-optimal decisions. Finally, we provide evidence that individuals' preferences over plan attributes (e.g., the degree of control provided) are even more important determinants of the DB/DC decision than expected outcomes (e.g., the relative generosity of the plans).
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Suggested Citation

  • Jeffrey R. Brown & Scott J. Weisbenner, 2012. "Why Do Individuals Choose Defined Contribution Plans? Evidence from Participants in a Large Public Plan," NBER Chapters,in: Retirement Benefits for State and Local Employees: Designing Pension Plans for the Twenty-First Century National Bureau of Economic Research, Inc.
  • Handle: RePEc:nbr:nberch:13229
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    References listed on IDEAS

    as
    1. Jeffrey R. Brown & Scott J. Weisbenner, 2009. "Who Chooses Defined Contribution Plans?," NBER Chapters,in: Social Security Policy in a Changing Environment, pages 131-161 National Bureau of Economic Research, Inc.
    2. James Banks & Richard Blundell & Agar Brugiavini, 2001. "Risk Pooling, Precautionary Saving and Consumption Growth," Review of Economic Studies, Oxford University Press, pages 757-779.
    3. Marie-Eve Lachance & Olivia S. Mitchell & Kent Smetters, 2003. "Guaranteeing Defined Contribution Pensions: The Option to Buy Back a Defined Benefit Promise," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 70(1), pages 1-16.
    4. Robert Novy-Marx & Joshua D. Rauh, 2009. "The Liabilities and Risks of State-Sponsored Pension Plans," Journal of Economic Perspectives, American Economic Association, pages 191-210.
    5. Robert L. Clark & Linda S. Ghent & Ann A. McDermed, 2006. "Pension Plan Choice among University Faculty," Southern Economic Journal, Southern Economic Association, vol. 72(3), pages 560-577, January.
    6. Moshe A. Milevsky & S. David Promislow, 2004. "Florida's Pension Election: From DB to DC and Back," Journal of Risk & Insurance, The American Risk and Insurance Association, vol. 71(3), pages 381-404.
    7. Jeffrey R. Brown & David W. Wilcox, 2009. "Discounting State and Local Pension Liabilities," American Economic Review, American Economic Association, pages 538-542.
    8. John B. Shoven & Sita N. Slavov, 2006. "Political Risk Versus Market Risk in Social Security," NBER Working Papers 12135, National Bureau of Economic Research, Inc.
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    Cited by:

    1. Clark, Robert L. & Hanson, Emma & Mitchell, Olivia S., 2016. "Lessons for public pensions from Utah's move to pension choice," Journal of Pension Economics and Finance, Cambridge University Press, pages 285-310.
    2. Zuzana Brokesova & Andrej Cupak & Gueorgui Kolev, 2017. "Financial literacy and voluntary savings for retirement in Slovakia," Working and Discussion Papers WP 10/2017, Research Department, National Bank of Slovakia.
    3. J. Michael Collins & Carly Urban, 2016. "The Role Of Information On Retirement Planning: Evidence From A Field Study," Economic Inquiry, Western Economic Association International, vol. 54(4), pages 1860-1872, October.
    4. Martin Boyer & Franca Glenzer, 2016. "Pensions, annuities, and long-term care insurance: On the impact of risk screening," Cahiers de recherche 1603, Chaire de recherche Industrielle Alliance sur les enjeux économiques des changements démographiques.

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